After a turbulent year, the market for non-fungible tokens and digital assets in 2023 is expected to see a period of stabilisation as regulation increases and enthusiasm cools, putting an end to its "Wild West" attribute1.
In Davos, Switzerland, this month saw global and business leaders meet to tackle the world's biggest issues. Since the last World Economic Forum meeting, the number of crypto companies attending were down with commentators suggesting this was to be expected given the global economic outlook, the $1.4 trillion wipe-out in 20222 in the crypto industry and the collapse of the major exchange FTX. Following the bear market, those companies that remain were being lauded as the "real deal" and focusing more on the promise of technology underlying cryptocurrencies and NFTs (i.e. blockchain).
PayPal President and CEO Dan Schulman is reported as saying, "It's important not to conflate cryptocurrencies and CBDCs, stablecoins and DLT… they're very different….the underlying tech has performed perfectly…The promise of a distributed ledger is that it can be faster and cheaper, to settle transactions simultaneously with no middlemen. That's an important thing." Blockchain technology was also raised as having potential benefits by Lynn Martin, President of the New York Stock Exchange. A recent example of blockchain came from a UN representative pointing to the blockchain payment product for distributing humanitarian aid in Ukraine3.
Predictions for NFT use cases are currently: Music, by tokenising merchandise to create additional income for creators; Luxury goods, pairing physical goods with digital ownership verification; Supply, enabling end-to-end tracking of goods; and Ticket Sales, by removing intermediaries. Industries that appear to be most active in the market are automotive, fashion, luxury, retail, food and beverage, sports, entertainment and music4.
The shift in focus at Davos is a clear indicator for 2023 – financial stability and consumer protection are definitely key factors. Bloomberg reported that Singapore’s Senior Minister Tharman Shanmugaratnam and European Central Bank Governing Council member Francois Villeroy de Galhau emphasised the need for crypto regulation, a sentiment echoed by UBS Group AG Chairman Colm Kelleher5. This sentiment has been echoed by the Central Bank of Ireland (CBI) in its Consumer Protection Discussion Paper 2022, wherein the CBI supports the development of blockchain technology-based products and the realisation of their potential. This is weighted against the need to ensure that "risks do not develop that could materially undermine confidence in the financial system, create instability, or harm consumers' interest"6. Publication of feedback on the paper is expected in Q2 2023.
The WEF reported at Davos7:
- Digital technologies will offer benefits to billions, but getting the right investment into technology is essential.
- The pandemic resulted in years of unplanned reinvention; we now need to make intentional change.
- There are more technologies available than there is money to fund them, so the strategic development of technology is key.
What will business and legal experts be focusing on?
Commentators such as NonFungible.com argue that the NFT market is undergoing a reorientation as NFTs find their true price point. The 2022 downturn has not led market participants to mothball the idea of NFTs. Rather, we are seeing the use of NFTs in new areas not associated with digital8. Luxury watch brand Breitling has announced that it will use NFTs as a digital certificate of the authenticity of its watches9. Gaming and eSports platforms such as Ubisoft and GameStop have introduced NFTs in the form of in-game purchases, with the underlying asset being a special feature such as a skin. BMW launched a first-of-its-kind, colour-changing concept car and mixed reality functions that are set to bring the offline and online closer than ever before. More Web3 projects are emerging such as from Porsche10 with its 7,500-piece NFT collection in collaboration with 3D artist Patrick Vogel and Unreal Engine 5. Fashion house Maison Valentino has unveiled its "Essential" line of luxury products, shot through AI11.
Regulators in Europe and further afield have expressed concerns that the volatility of NFT prices could lead to NFTs being used as a vehicle for money laundering. Like crypto-currencies, NFT prices can fluctuate dramatically, providing an opportunity for money launderers to transfer large amounts of fiat currency under the guise of a legitimate transaction.
The Financial Action Task Force raised this in its guidance on virtual assets, signalling to national regulators the need to address this risk (link to pdf here).
Check out our article "Is Crypto the next asset class for Irish Funds?" While NFTs that represent art, music and video are generally to be excluded from the scope of MiCA, some may not. In particular, a collection or series of NFTs may well be considered within the scope of MiCA. Care will be needed by market players to ensure compliance.
Intellectual Property and Smart Contracts:
The position around IP issues depends on lots of aspects and can be complex. We continue to see questions arising from the interpretation of the contract provisions related to the NFT purchase or sale. Separately, there is growing interest in provisions that permit "perpetual royalties". This would allow an IP owner to secure a royalty payment for onward sales of the NFT via the blockchain network tokens that underpin the NFT. The NFT would only transfer on payment of the secondary royalty fee. This concept is being considered as part of a some NFT marketplaces.
There is more to keep watch over, such as:
- Consumer Protection
- Data Privacy
- Cyber Security
While the high-flying salad days of the market may be over, market participants and regulators are agreed that NFTs will continue to be a feature of the digital economy. At present, the regulatory authorities seem to be forming a view on how exactly to classify an NFT for the purposes of regulation. There is, however, a clear intention at FATF and with the European institutions that regulation will in time get to grips with NFTs. Also, there is a growing body of case law on NFTs (e.g. legal property; crypto fraud; trademark infringements).